What rising interest rates mean for real estate investors

Normally, news of falling house prices – meaning the market is starting to favor buyers over sellers – would be greeted with a sigh of relief by those trying to buy their first home.

But the rapid rise in interest rates, imposed by the Reserve Bank to rein in runaway inflation, has thrown a curveball for first-time homebuyers. Some will no longer qualify for a mortgage and even if they do qualify, many fear they will not be able to keep up with the ever-increasing mortgage payments.

This is not the case with investors. Under our current tax system, investors can claim a tax deduction for the interest they pay on mortgages on their investment properties. Indeed, negative gearing allows real estate investors in loss to reduce the tax they pay on their other income.

The owners do not have the same luxury.

Rising interest rates will increase the cost of negative leverage tax breaks. So Australian taxpayers will be paying billions of dollars so homeowners can reduce their taxable income in years to come.

“We will see a substantial increase in the cost of negative gearing,” says AMP economist Shane Oliver. “I wouldn’t be surprised if we got to $5 billion to $6 billion a year in net rental income.”

Even better news for investors – though painful for tenants – is that rents are rising rapidly as housing demand outstrips supply.

But before jumping into the market to start or complete an investment portfolio, ask yourself if prices will drop further in your area of ​​interest and by how much. If you wait too long, you risk missing the boat, as some analysts predict the drop will be short and sharp.

House prices are falling at their fastest pace since the GFC, and market conditions are “likely to deteriorate” as interest rates continue to rise, according to real estate analyst firm CoreLogic.

The latest data shows that the country’s median property value has fallen 2% since the start of May, to $747,182.

“Although the housing market has only been in decline for three months…the rate of decline is comparable to the onset of the global financial crisis in 2008 and the steep decline of the early 1980s,” the director said. CoreLogic Research, Tim Lawless, in Release July Stats.
In an interview with ABC News, he said: “I think this downturn will be similar to the global financial crisis in that it will be quite short and sharp.”

Major cities hardest hit

The median house price in Australia fell around 8.5% year-over-year during the GFC, according to CoreLogic.

Many analysts predict that residential property prices will fall by an average of 10% to 20% (from peak to trough), with the two most expensive cities, Sydney and Melbourne, likely to suffer the biggest declines. Yet this would only partially reverse the 28.6% pandemic surge.

ANZ economists agree the downturn is likely to be short-lived. They predict house prices will fall 18% over the remainder of 2022 and 2023, but recover in 2024 and rise 5% that year.

Tenants are also at a disadvantage in today’s real estate market, as rents have risen rapidly. The national average rent jumped 2.8% in the last quarter and rose nearly 10% in the past year. To put this into context, it is very rare to see housing rents increase by more than, say, 3-4% per year.

“Rental markets are extremely tight, with vacancy rates around 1% or lower in many parts of Australia,” says Lawless. “The number of rental listings available nationwide has fallen by a third from the five-year average, with no signs of an increase in rental supply. On top of an already tight rental supply , it is likely that demand will continue to increase as the number of overseas arrivals mounts.”

Rising rents are usually an incentive for investors to increase their holdings.

Some investors are also aware that the tax breaks they receive may not last forever, but any changes would not be retroactive.

While the new Federal Labor government has ruled out any changes to the negative gear (which was its policy leading up to the 2019 election), many commentators point out that it puts first-time home buyers at a disadvantage.

A report by the Grattan Institute, a policy think tank, released a year before the May 2022 federal election, called on Australia’s next government to end one of the country’s favorite tax breaks – the negative gear.

“The current CGT [capital gains tax] discounting and negative gearing agreements distort investment decisions, increase price volatility in real estate markets and put upward pressure on real estate prices,” the report from the CEO of the Grattan Institute, Danielle Wood.

Another incentive for investors is that in the spring they will have more choices as the listings of homes and units increase.

“A larger flow of announced inventory amid falling demand is great news for active buyers, who will have more choice and less urgency,” Lawless says. “These tight rental markets, improving yields and stronger buying conditions should help maintain a floor below investment demand.”

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Leslie M. Gill